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Independent research for global prosperity

Later this year, India’s 15th Finance Commission will review the formula used by its predecessor to determine how much central tax revenue will be devolved to each state for fiscal years 2020-21 through 2024-25. Currently, 7.5 percent of the fiscal devolution (an estimated $6.9-12 billion per year) is allocated in proportion to their forest area circa 2013. These “ecological fiscal transfers” (EFTs) provide Indian states with the incentive to increase their forestry budgets as an investment in increased future shares of central taxes. In this paper, we look at whether states are yet taking advantage of this opportunity. We find that states increased their forestry budgets by 19 percent in three years after the introduction of EFTs relative to three years prior. However, this increase is considerably less than the 42 percent overall budget increase over the same time period. We surmise that states are not yet certain that EFTs will continue in such a way that increases in forest cover will be rewarded with increases in revenue. We recommend that the 15th Finance Commission resolve this uncertainty for states by (i) keeping forests in the devolution formula, and (ii) updating the reference year (e.g. 2019). By doing so India’s EFTs can fulfill their potential as an innovative mechanism for incentivizing states to protect and restore forests, thereby mitigating climate change.

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